Is there a connecting story that runs across Coal, Natural Gas and Crude Oil shortages?
Lot has been written on the energy crisis and on the overall supply chain challenges in the post-pandemic world. But very few have focused on the connecting plot and much less on the root cause that triggered the energy crisis. We attempt to do that. Here we go.
One would have expected the world to emerge from Covid shock awash with oversupply, as would happen after any sharp and sudden slowdown. Far from that, the world is witnessing exactly the opposite, esp. in the fuel supplies. European and Asian gas prices are at an all-time high, the oil price is at a three-year high, and the price of coal is soaring on the back of energy shortages across China, India and Germany.
What went wrong and why?
It is fascinating to see the connection between seemingly unrelated events that have caused this crisis. Few would think that anything other than pandemic would be at the heart of the problem. But if one digs deeper, that is where one is led to. As one figures out, the crisis is not so much rooted in pandemic, but in geopolitics. It is another matter that this particular geopolitical issue of Australian coal ban by China got triggered by pandemic allegations.
Here is the sequence of events. All of a sudden, late last year, China announced the ban on Australian coal imports. It was a massive decision with huge implications for coal supply chain. Remember, China imported near 58% of its coal imports from Australia in 2019 and in 2020. This was like shutting the entire coal imports into China overnight. Since coal movements are freight intensive process, it is not easy and very time-consuming to reconfigure the shipping supply chain. So, what we ended up with was the huge pile of coal stocks in Chinese ports and a huge line-up of ships loaded with coal. As per some estimates, there are still over 50 loaded ships in Chinese ports in as late as September 2021.
The natural question that arises is, if the coal ban started a year back, why didn’t the coal crisis start much earlier. One must thank the severe lockdowns in the first two quarters of this year for that. When the power demand came back in the third quarter with vengeance when the economy started opening up, depleting inventory in the supply chain started showing up in the form of surge in coal prices. In a normal low liquidity environment, the uptick in prices would have been manageable, given the short-term nature of the problem. Liquidity is anything but normal now. With momentum traders and punters (read hedge funds) awash with liquidity, anything that has reason to rise by X will be made to sky-rocket by 3X or 4X. It all boils down to whether one can spot and spin a story. That is all required in this highly speculative environment (high liquidity) to take any commodity to sky- high prices. That is the game hedge funds are good at, esp. when the liquidity taps are wide open. Look at what is happening to prices of many other commodities such as soda ash, palm oils, sugar and metals. No limits to where they can take the prices to.
Spinning story doesn’t stop with just coal. It goes beyond that, as it is easy for the hedge funds that trade actively in futures market to stretch that story to the so called substitutes. If natural gas is a substitute to coal and crude is a substitute to gas, why not spin them into sky-high orbits as well. That is precisely what investment banks like Goldman in collusion with hedge funds do. For evidence, one doesn’t need to look further than its recent report calling out for 110$ target price for crude oil. Of course, severe winters in Europe and gas supply hiccups from Russia to Europe couldn’t have come at a better time for the hedge funds that watch like hawks for the next prey.
In summary, what started off as a geo-political issue has morphed into a widespread global energy crisis by confluence of factors like shipping/container bottlenecks, surge in demand on opening-up, severe winter in Europe, Russia’s reluctance to supply gas to Western Europe, China’s stockpiling of domestic coal and gas reserves etc. Not to forget that the biggest role in this mayhem is being played by the hedge funds and investment banks in amplifying these short-term supply mismatch issues into a survival issue for many countries that are heavily import dependent for such commodities by jacking up the prices to unreasonable levels. But, if that is the nature of the beast (hedge funds), questioning their theatrics will be unwise.
Of course, one might argue that the chronic underinvestment in fossil fuels driven by ESG and EV frenzy etc. could structurally keep the oil prices high (as argued by leading magazines like Economist). But the counter point is that these pressures are not new and have been there for long time if you go back in time (at least 4 to 5 years) and check. Current crazy trend is more of a “narrative following price action” than anything else. Only time will tell who is right.
Interesting times to watch out for!!